Volatility monitored as "flash" trading ends

NEW YORK (Reuters) - Rules that may curb high frequency trading came into effect on exchanges from New York to London on Tuesday, threatening to crimp profits for the firms that took advantage of the controversial method.

Aside from the impact on traders involved in high frequency or "flash" trading, traders say it is too early to say if the move will affect market volatility.

Both the Nasdaq OMX and the BATS stock exchanges banned "flash orders" while the London Stock Exchange ended rebates to high frequency traders following accusations of unfairness over the summer.

Nasdaq said flash orders, which it only introduced in June, were not a material part of its business, but they did not break out the percentage of their trades that were flash orders. Both exchanges announced the ban in early August.

Suggestions that the move could increase volatility were highlighted on a day when U.S. stock indexes fell more than 2.0 percent and volatility, as measured by the CBOE's volatility index , hit its highest level since early July.

Critics say flash orders, which allow some traders to view buy and sell orders a fraction of a second before the wider market, give a few players an unfair advantage by using high-speed computers and complex algorithms. The New York Stock exchange does not allow the practice.

Advocates of high frequency trading say the traders bring much-needed liquidity to the market and rebates on trades offered by some exchanges to attract the lucrative business were fully justified to help markets operate more smoothly.

"Today is the day that you see flash orders disappear in major venues so you actually have a concrete point, a frame of reference from which you draw conclusions in the month or two leading up to it and the month or two following it," said Sal Arnuk, co head of Themis Trading in Chatham, New Jersey.

High frequency trading has drawn fire in recent months. The Securities and Exchange Commission said it will look at the various practices as part of a broad review of markets, while U.S. Senator Charles Schumer warned he may introduce legislation to ban flash orders outright.

Irene Aldridge, managing partner at Able Alpha Trading in New York, a vociferous advocate of high frequency trading, said the banning of flash orders was unlikely to have a significant impact on the market as a relatively small number of high frequency traders use the methods.

But she said the London Stock Exchange's decision to ban rebates paid to high frequency traders for providing liquidity could increase the spreads that brokers ask for trading stocks and reduce liquidity on some securities.

"(Rebates) are compensating algorithms that provide liquidity to the market," said Aldridge.

"It may hurt London Stock Exchange the most because it will reduce their liquidity, and when liquidity gets reduced the first thing that happens is that the bid-ask spreads go up ... it's going to be more expensive to trade on the London Stock Exchange."

Art Hogan, chief market economist at Jefferies in New York, said the ban may lead to a drop in trading volume but said it was too early to say if volatility would increase.

"We'll have to see if it increases volatility or not," he said. "The jury's still out as to what adverse effects it might bring."

Another trading venue, Direct Edge, still allows flash orders, but say it does not convey an advantage to high frequency traders.

if it was introduced only in June, who cares if it is eliminated now? The market survived for a long time without this.

On the other hand, thinking that the market is tilted towards large players can also reduce participation by smaller players, who think it is rigged. It is not just the large players that make the markets. Without the appearance of openness, fairness and trust, all will suffer.